Yesterday, the SEC’s Office of the Chief Accountant and the Division of Corporate Finance issued guidance – via Staff Accounting Bulletin No. 120 – on how to properly account for “spring-loaded awards” made to executives. Spring-loaded awards are awards granted by a company to an executive shortly before disclosure of material non-public information to which the market is likely to react positively.
As stated in the SEC’s press release, SAB No. 120 says that companies estimating the fair value of spring-loaded awards in accordance with ASC Topic 718 “must consider the impact that the material nonpublic information will have upon release.” Here are the main changes that SAB No. 120 makes:
– Amends and replaces the interpretive guidance in Topic 14.D., Certain Assumptions Used in Valuation Methods. SAB No. 120 states that when companies are granting share-based awards while in possession of MNPI, companies should consider “whether adjustments to the current price of the underlying share or the expected volatility of the price of the underlying share for the expected term of the share-based payment award are appropriate when applying a fair-value-based measurement method to estimate the cost of its share-based payment transactions.”
– Rescinds guidance in Subtopic 14.A., Share-Based Payment Transactions with Nonemployees, noting that ASU 2018-07 made Subtopic 14.A. no longer relevant.
– Edits to the following subtopics to conform to updated GAAP terminology from FASB’s ASC Topic 718 (as updated by FASB’s Accounting Standards Updates): Subtopics 14.B., Transition from Nonpublic to Public Entity Status; 14.C., Valuation Methods; 14.D., Certain Assumptions Used in Valuation Methods; 14.E., FASB ASC Topic 718, Compensation – Stock Compensation, and Certain Redeemable Financial Instruments; 14.F., Classification of Compensation Expense Associated with Share-Based Payment Arrangements; 14.I., Capitalization of Compensation Cost Related to Share-Based Payment Arrangements; and 5.T., Accounting for Expenses or Liabilities Paid by Principal Stockholder(s).
This guidance is interesting because the Staff calls out the application of its guidance when companies have positive MNPI. As a result, SAB No. 120 seems to lean towards a concept of “fairness,” which we’ve also seen previously in the say-on-pay / pay ratio context. Make sure this guidance makes it into your internal controls and disclosure checks to avoid any surprises down the road!
Compensation committees are again tackling setting executive pay under uncertain circumstances. Semler Brossy issued a brief memo on the three trends they expect for 2021 executive pay levels:
1. An overall increase in CEO pay in both the S&P 500 and Russell 3000 – and it looks like early indications are bearing this out: companies that have already disclosed 2021 pay levels are averaging a 9.3% increase in base salaries.
2. A growing variance in compensation between the top and bottom corporate performers – the sectors that did well during the pandemic should see larger increases in target pay levels and stronger incentive-pay outcomes.
3. An uptick in the prevalence of performance-based equity – last year, companies moved away from performance-based stock towards time-based vehicles given the uncertainty of the pandemic. Companies will likely return to having performance-based stock in their long-term incentive plans.
The memo also emphasizes that clear rationale should be provided in the proxy statement for special actions like one-time awards or discretionary payouts. We blogged previously about lower say-on-pay votes this year due to Covid-related pay actions – we’ll be on the lookout for how boards and companies incorporate this investor feedback as they set executive pay levels and prepare pay-related disclosures this year. Mark your calendars for our December 16th webcast, “Compensation Committee Responsiveness: How to Regain High Say-on-Pay Support.”
Here’s something that my colleague John Jenkins wrote yesterday for TheCorporateCounsel.net: If you’re looking for a primer on how not to implement disclosure controls & procedures surrounding the disclosure of executive perks and stock pledges, be sure to check out this settled enforcement proceeding that the SEC announced yesterday. This excerpt from the SEC’s press release summarizes the proceeding:
The Securities and Exchange Commission today announced that Texas-based oilfield services company ProPetro Holding Corp. and its founder and former CEO Dale Redman have agreed to settle charges that they failed to properly disclose some of Redman’s executive perks and two stock pledges.
The SEC’s order finds that Redman caused ProPetro to incur $380,594 worth of personal and travel expenses unrelated to the performance of his duties as CEO. He also failed to disclose to company personnel that he had pledged all of his ProPetro stock in two private real estate transactions. During the same period, ProPetro failed to properly disclose $47,591 in additional, authorized perks it paid to Redman. As a result of these failures, the company issued public filings that included material misstatements regarding executive perks and stock ownership, and failed to accurately record Redman’s perks in its books and records.
While the defendants neither admitted nor denied the allegations made by the SEC, they consented to a C&D and the former CEO agreed to pay a $195,046 penalty. But in order to understand the alleged shortcomings in the company’s disclosure controls & procedures surrounding perks and pledges, you need to check out what the SEC claimed in its Order Instituting Proceedings. Highlights include:
– The CEO had a 50% ownership interest in a company that owned an airplane that he used for business travel. It sent invoices to the company for his flights, which the CEO initialed for approval and passed on to the accounts payable supervisor in the same manner as all other vendor invoices.
– Despite a policy prohibiting personal use of company credit cards, the CEO and his family made over $125,000 of personal charges that were not reimbursed and were not disclosed in the company’s proxy statement.
– The CEO pledged stock without obtaining prior board authorization, and subsequently obtained board approval of a negative pledge arrangement with another bank that prohibited him from disposing of the stock. He did not inform the board of the earlier pledge, nor did the company disclose either pledge in its proxy statements for several years.
How did all of this (and more) get missed? Part of the answer appears to be a lax approach to handling D&O questionnaires. Here are paragraphs 24 & 25 from the SEC’s Order:
24. On January 27, 2017, approximately one week after the close on the loan for his first ranch with its associated stock pledge, Redman completed his “D&O Questionnaire” for the disclosures in the company’s Form S-1 Registration Statement. Redman completed and signed the 2017 D&O Questionnaire, but left the line item for pledged shares blank. In 2018, Redman did not complete a D&O Questionnaire at all. On January 21, 2019, Redman completed the D&O Questionnaire but did not submit Schedule B, “Security Ownership and Recent Transactions in Company Securities,” which should have described his ProPetro equity ownership including his stock pledges.
25. Redman also did not identify in his D&O Questionnaires any of his personal trips on the Aviation Co. Learjet, the personal charges he made on the corporate credit card, or the additional perquisites authorized by the company. In his 2017 D&O Questionnaire, Redman included some perquisites for his company car, but failed to include any of the additional perquisites detailed above. In 2018, Redman failed to complete a D&O Questionnaire. On January 21, 2019, although Redman included some perquisites in his D&O Questionnaire, he did not disclose the personal air travel, any of the personal credit card charges reimbursed by the company that year or the various previously authorized perquisites detailed above.
The good news for the company was that the SEC lauded its cooperation. The bad news for the company’s executives was that in order to get that pat on the back, the board replaced them with an entirely new management team.
This 29-page memo from FW Cook analyzes 2021 director pay at 300 companies of various sizes & industries. For the most part, practices around board retainers, equity grants, annual compensation limits and stock ownership guidelines have remained pretty steady from year to year. One area that is changing, though, is that more companies are establishing an ESG-related committee. Here’s what FW Cook found about that:
Thirty-six of the 300-company sample, (12%) included an Environmental, Social, and Governance (ESG)-related committee. Of those companies, 22 were in the Energy sector (61%), five were in the Financial Services sector (14%), five were in the Retail sector, and four were in the Industrial sector (11%). Additionally, 18 were large-cap (50%), 13 were mid-cap (36%), and only five (14%) were small-cap.
ESG committee chair retainers were $15,000 at the median, which we observe to be aligned with the median of Nominating/Governance committee chair retainers for the 2021 study broadly. About one-third of companies with an ESG committee provide a member retainer or meeting fees.
I blogged a couple of years ago about research showing that high pay ratios might result in low say-on-pay votes. At that time, there weren’t many investor policies that were expressly naming pay ratio as a factor in the say-on-pay analysis, but the data showed that investors might be signaling indirect dissatisfaction and that employees were less productive. Trillium’s say-on-pay voting policy has been an exception. Lynn highlighted earlier this year that the asset manager goes above & beyond the ISS SRI voting recommendations that it typically follows – including by saying that funds will vote “against” pay if the CEO pay ratio exceeds 50:1, which is a policy that’s been in place since 2019.
Now, this blog from As You Sow points out that Trillium is not alone: the pandemic and wage inequality have led more investors to incorporate “fairness” concepts into the say-on-pay analysis. That means that pay ratio caps & other fairness concepts might start to affect say-on-pay votes, especially if your shareholder base includes SRI funds, pension funds, and UK, EU and/or Canadian funds. Here are a few examples from the blog:
– Aviva, a UK asset manager with $414 billion assets under management, says in its global voting policy that “… Fairness and equality need to be more prominent principles in shaping the culture of executive pay. … Boards should also show more restraint in approving significant pay-outs or increases to pay opportunity during periods of low wage inflation, cost cutting initiatives and when there has been a loss in shareholder value.” Among other problematic pay practices, Aviva expressly says that it will not support an “unjustifiable increase in the executive pay ratio relative to the median for the workforce.”
– NEI Investments, a Canadian asset manager focused on responsible investing, says in its proxy voting guidelines, “A disconnect between executive compensation and salaries at lower levels of the company may de- motivate employees, and thus undermine the strategic objective of attracting and retaining talented people. Concerns have also been raised that compensation design and high pay levels for top executives do not take into account how people are actually motivated and lead to needlessly complex pay disclosure in proxy circulars.” NEI votes against pay if the CEO pay ratio exceeds 3:1 or if the CEO or other NEO pay is more than 280x US median household income.
– Northstar Asset Management says in its proxy voting guidelines that it will “only approve executive compensation packages in which equity, stock options, bonuses, and benefits packages for all non-executive employees is equivalent to that of executive officers.”
– Castlefield Investment Partners, another UK asset manager, says in its corporate governance & guidelines that, “Where executive base salary is in excess of between 30-35 times the UK median salary and 60-65 times that of the lowest paid employee, executive pay should be deemed excessive and remuneration should be voted AGAINST. The lower multiple should be enforced where the company in question is not a living wage employer.”
– In connection with the pandemic, T. Rowe Price says in its proxy voting guidelines that, “For our 2021 proxy voting decisions, alongside our traditional assessment of pay-for-performance alignment, pay practices and absolute level of pay, we will also assess pay outcomes through the lens of fairness.”
While these pay ratio caps are not yet widespread, it’s something to watch. Long-term pay arrangements that are approved today could affect the pay ratio several years down the road – and that could be a problem for companies & directors if this trend takes off. Continued scrutiny of wage inequality as a factor in say-on-pay would mean that boards & compensation committees (and those who advise them) may need to give more weight to pay ratio as part of approving executive pay packages. You should also keep the impact of these policies in mind in connection with overseeing workforce compensation & benefits, engaging with investors, and preparing proxy disclosures.
This Bloomberg Law article reports on a recent House bill, “No Bonuses in Bankruptcy Act of 2021,” introduced by Rep. Cheri Bustos. The article notes that while bankrupt companies need court approval to award executive bonuses, there’s a loophole for pre-bankruptcy bonuses. In addition to barring executives making more than $250k a year from receiving bonuses during bankruptcy, the bill would allow the DOJ’s bankruptcy watchdog to claw back bonuses paid within 180 days prior to the bankruptcy filing.
This bill comes on the heels of a GAO report published in September, which showed that 42 companies awarded about $165 million in pre-bankruptcy retention bonuses ahead of bankruptcy filings. The GAO report also notes that nearly all stakeholders GAO interviewed viewed pre-bankruptcy bonuses as problematic (though on the flip side, others have argued that companies need to give bonuses to retain talent during the bankruptcy process).
Bottom line – whether or not in a bankruptcy context, if a company’s executives get hefty sums while employees face layoffs or steep salary cuts, that will likely get a lot of (negative) attention. Companies may want to get started on their pay ratio and compensation narratives now if there’s any chance for public backlash.
On Monday, Glass Lewis announced the publication of its 2022 Policy Guidelines. As always, the first few pages of the Guidelines summarize the policy changes for 2022. This year’s changes seem to focus largely on diversity and SPAC governance, but Glass Lewis clarified its existing policies on several compensation topics, including:
– Linking Executive Pay to Environmental & Social Criteria: We have outlined our current approach to the use of E&S metrics in the variable incentive programs for named executive officers. Glass Lewis highlights the use of E&S metrics in our analysis of the advisory vote on executive compensation. However, Glass Lewis does not maintain a policy on the inclusion of such metrics or whether these metrics should be used in either a company’s short- or long-term incentive program. As with other types of metrics, where E&S metrics are included, as determined by the company, we expect robust disclosure on the metrics selected, the rigor of performance targets, and the determination of corresponding payout opportunities. For qualitative E&S metrics, the company should provide shareholders with a thorough understanding of how these metrics will be or were assessed.
– Short- and Long-Term Incentives: Our guidance related to Glass Lewis’ analysis of the short-term incentive awards has been clarified to note that Glass Lewis will consider adjustments to GAAP financial results in its assessment of the incentive’s effectiveness at tying executive pay to performance. As with the short-term incentive awards, our analysis of long-term incentive grants also considers the basis for any adjustments to metrics or results. Thus, clear disclosure from companies is equally important for long-term incentive awards.
– Grants of Front-Loaded Awards: We have clarified our guidance related to Glass Lewis’ analysis of so-called front-loaded incentive awards. Specifically, while we continue to examine the quantum of award on an annualized basis for the full vesting period of the awards, Glass Lewis also considers the impact of the overall size of awards on dilution of shareholder wealth.
We’re posting memos in our “Proxy Advisors” Practice Area to get you up to speed on what you need to know for the 2022 proxy season.
Here’s BDO’s latest study examining CEO & CFO compensation plans and pay levels of 600 middle-market public companies. Data was collected from proxy statements filed between April 2020 and March 2021 – right in the thick of the pandemic. The study found that total CEO and CFO pay levels for middle market companies rose 12.1% and 10.1%, respectively – these year-over-year increases consisted of salary increases, annual incentives and long-term incentives. Other findings include:
– Further breaking down the year-over-year change, CEO salaries increased by 1.5%, total cash compensation increased by 10.5% and long term incentives by 9.4%. CFO salaries increased by 4%, total cash compensation increased by 8.1% and long term incentives by 8.8%.
– Pay levels for CFOs are approximately 43% of CEO pay for the sampled companies.
– Full-value shares dominate long-term incentives; stock options were only a small fraction of the long-term incentive mix.
– Variable compensation for both CEOs and CFOs increased in tandem with company size.
For all of us securities lawyers who didn’t major in accounting, FW Cook published a 13-page primer covering the most pertinent provisions of accounting for stock compensation under FASB ASC Topic 718. Below are some of the topics covered – junior attorneys in particular might benefit from reading up on the 718 “basics” before proxy season:
– Scope of ASC 718
– Compensation cost for equity and liability awards
– Accounting treatment in clawback provisions and non-compete agreements
– Accounting treatment for modifications to service and performance vesting conditions
Yesterday, ISS announced that for companies with annual meetings between February 1st and September 15th of next year, its peer group review & submission window will open this upcoming Monday, November 15th – and will close at 8pm ET on Friday, December 3rd. ISS opens this window twice per year for companies to provide input (but note that the company-submitted peers are just one factor in the ISS determination process). Here’s more detail:
Companies that have made no changes to their previous proxy-disclosed executive compensation benchmarking peers, or companies that do not wish to provide this information in advance, are under no obligation to participate. For companies that do not submit any information, the proxy-disclosed peers from the company’s last proxy filing will automatically be factored into ISS’ peer group construction process.
Additional information on the ISS peer submission process, including links to ISS’ current recent peer selection methodology for the U.S., Canada, and Europe is available on the ISS website.
Participation in this window has been more relevant the last couple of years, because the changing business environment means that industry & market competitors – and overall competition for talent – is shifting. This Longnecker blog explains why creating & maintaining an appropriate peer group is an important exercise with both proxy disclosure and human capital implications, and walks through 5 factors to consider.